Abstract
The Insolvency and Bankruptcy Code (IBC), 2016, represents a paradigm shift in India’s insolvency framework, aiming to expedite the resolution process and replace outdated laws. Since its inception, the IBC has been a dynamic instrument, adapting to societal shifts and economic demands. A significant evolution within the IBC is the inclusion of personal guarantors to corporate debtors, effective from December 1, 2019. This extension was operationalized through the Insolvency and Bankruptcy (Application to Adjudicating Authority for Insolvency Resolution Process for Personal Guarantors to Corporate Debtors) Rules, 2019, and the corresponding regulations. The article delves into the ramifications of this extension, analyzing the insolvency resolution processes for personal guarantors and their impact on the credit ecosystem. Historically, the liability of a surety, as per the Indian Contract Act, 1872, is coextensive with that of the principal debtor. The IBC initially included provisions for personal guarantors, but ambiguities arose due to the non-commencement of Part III. Landmark cases, such as SBI v. V. Ramakrishnan, highlighted these issues, prompting legislative amendments in 2019 that clarified the scope of personal guarantor liability. The Supreme Court’s ruling in Lalit Kumar v. UOI resolved disputes regarding the insolvency resolution of personal guarantors, affirming the IBC’s applicability to them. This research article seeks to unravel the complexities surrounding personal guarantors in the Corporate Insolvency Resolution Process (CIRP), examining when creditors may initiate action and the extent of liability invoked during CIRP. It also explores the historical context of individual insolvency laws and the transformative effect of the IBC.
Keywords: Insolvency, Bankruptcy, Personal Guarantors, Insolvency and Bankruptcy Code, CIRP, Corporate Insolvency
INTRODUCTION
India has grappled with bankruptcy and insolvency challenges for decades, posing significant risks to banks and financial institutions due to credit defaults. Despite various legislative attempts to address these issues, previous laws and codes proved ineffective in providing relief to creditors. The Insolvency and Bankruptcy Code, 2016 (IBC 2016) emerged as a comprehensive legislation applicable to both corporate and non-corporate entities, promising transparency, simplicity, and improved infrastructure within the liquidation system. Its transition from the “Debtor-in-possession” to the “Creditor-in-Control” doctrine offered a ray of hope, providing creditors with relief and distressed companies with opportunities for turnaround and revival.
Historically, efforts to tackle insolvency in India began with the Presidency Towns Insolvency Act, 1909 (PTIA, 1909)[1], and the Provincial Insolvency Act, 1920 (PIA, 1920)[2], which addressed insolvencies in specific regions. Post-independence, a provision under the Companies Act targeted corporate insolvencies, empowering creditors to file for the dissolution of insolvent companies. Recognizing the need for a revamped legislative framework, committees were formed, leading to the enactment of the Sick Industrial Companies (Special Provisions) Act[3], 1986 (SICA 1986). However, SICA’s efficacy was questioned, prompting further amendments, which unfortunately were never implemented. Subsequent recommendations led to the proposal and eventual enactment of the IBC 2016, signalling a transformative shift in India’s legal and economic landscape. The IBC 2016 aimed to expedite the resolution of insolvent companies while maximizing resource returns.
Initially, only Chapter II of the IBC 2016[4], pertaining to corporate insolvencies, was operational, leaving personal guarantees in a complex legal limbo. Personal guarantors, individuals providing surety for corporate debt repayment, were excluded from the IBC’s ambit until a crucial notification by the Ministry of Corporate Affairs. This notification expanded the IBC’s scope to include personal guarantors, acknowledging the holistic nature of insolvency resolution. This inclusion allows creditors to pursue outstanding debts from personal guarantors in the event of default by the principal debtor, thereby enhancing creditors’ recourse. However, it also elevates the risk for personal guarantors, potentially exposing their personal assets. Thus, it becomes imperative for personal guarantors to comprehend their obligations and potential liabilities before assuming such roles. The initiation of insolvency proceedings under the IBC involves a structured mechanism known as the Corporate Insolvency Resolution Process (CIRP), offering avenues for company revival or liquidation. Financial creditors, operational creditors, and debtor companies can trigger CIRP, thereby providing a multi-dimensional approach to insolvency resolution.
WHAT ARE PERSONAL GUARANTORS AND WHAT DOES THE IBC SAY ABOUT THEM?
When a company defaults in repaying loans or credit facilities for a long period, the lenders move the National Company Law Tribunal (NCLT) to admit it into the insolvency resolution process. If the NCLT admits the company into the process, an RP is appointed to take stock of the company’s finances and to run the company to repay its lenders. An RP effectively takes over the operations of the company. The intention of the IBC is to make a debt-ridden company operational again.
A personal guarantor is a person who gives a written assurance to a lender that a company will repay the loan/ credit facility it has obtained. In the event the company does not repay the loan/credit facility, his personal assets can be attached by the lender. Prior to the IBC, banks would have had to move the Debt Recovery Tribunal (DRT) to enforce a personal guarantee.
The personal guarantee is generally given by the promoters/ shareholders of the corporate houses in respect of a loan being availed from banks/ financial institutions (financial creditors).
However, in 2019, the government brought in new provisions in the IBC that enabled a creditor or the RP of a company to move applications under the IBC to enforce personal guarantees. For instance, if a company has been admitted into the insolvency resolution process and its promoter had given a personal guarantee to its lenders, the lenders, either on their own or through the RP, can move an insolvency plea against the promoter. The NCLT will then appoint another RP to represent the personal guarantor. The RP will collate the information related to the nature of the loan given to the company, the amount in default and the role of the personal guarantor. The NCLT, upon analysis of the RP’s report, will determine whether the personal guarantor must be admitted into the insolvency process or not. If a personal guarantor is admitted into the process, his assets will be attached by the RP for recovery of the loan.
These provisions were challenged on the ground that in the whole scheme of things, the personal guarantor would have no right to argue or present his case before an RP was appointed by the NCLT, thereby violating the principles of natural justice guaranteed by the constitution. It was further alleged that an RP’s report would essentially spell out the fate of a personal guarantor, thereby making such powers prone to abuse.
THE SUPREME COURT’S CLARIFICATION ON PERSONAL GUARANTOR LIABILITY
The legal intricacies of personal guarantees in the context of corporate insolvency under the Insolvency and Bankruptcy Code, 2016 (IBC), have been a subject of considerable debate. A personal guarantee commits an individual—the guarantor—to repay a debt if the primary borrower, the corporate debtor, defaults. The Supreme Court’s ruling in Surendra B. Jiwrajika v. Omkara Assets Reconstruction Private Limited[5] on November 9, 2023, has significantly clarified the liability of personal guarantors under the IBC, although some questions remain unresolved.
The Insolvency and Bankruptcy Code (Second Amendment) Act, 2018, and the subsequent Notification No. S.O. 4126 dated November 15, 2019[6], have brought personal guarantors directly under the purview of insolvency proceedings. This legislative change allows creditors to initiate insolvency proceedings against personal guarantors without first having to pursue the corporate debtor. The Supreme Court’s recent judgment has affirmed the constitutionality of these provisions and delineated the extent of liability for personal guarantors.
This judgment is pivotal as it enhances the creditors’ ability to recover debts from personal guarantors following the corporate insolvency resolution process (CIRP) of the corporate debtor. It establishes a “dual safety-net,” enabling creditors to claim their dues not only from the corporate entity but also from the personal guarantors. The outcome of the Omkara Assets case has thus reinforced the creditors’ bargaining power, while simultaneously narrowing the protective measures available to personal guarantors under the IBC.
LIABILITY OF PERSONAL GUARANTORS
The liability of personal guarantors, as stipulated under Section 128 of the Indian Contract Act, 1872 (ICA)[7], is co-extensive with that of the corporate debtor, determined by the terms of the guarantee contract. Legal proceedings against both entities can be initiated concurrently or in a preferred sequence by creditors. Despite the discharge of the corporate debtor’s liability upon the acceptance of a resolution plan by the Committee of Creditors (CoC), the liability of the personal guarantor persists.
Precedents such as Maharashtra State Electricity Board Bombay v. Official Liquidator[8] establish that the discharge of the corporate debtor’s liability through insolvency proceedings does not automatically absolve the personal guarantor. The Supreme Court rulings in cases like State Bank of India v. V. Ramakrishnan[9] and Committee of Creditors of Essar Steel India Limited v. Satish Kumar Gupta[10] clarify that the approval of a resolution plan does not discharge the guarantor’s obligations unless specifically provided in the contract or as a result of voluntary action by the corporate debtor.
The recent decision in Lalit Kumar Jain v. Union of India[11] by the Supreme Court delineated the conditions for the release of personal guarantors’ liabilities. The Court held that the release of the guarantor from its responsibilities is contingent upon two conditions: firstly, unless the language of the contract states otherwise and, secondly, if it is the result of a voluntary action by the corporate debtor, such as a release, discharge, composition, or modification of the guarantee agreement. The Supreme Court therein defined the lines of liability of the personal guarantors under the Code, and, while dismissing the petitions, declared the Notification of 2019 to be legally sound and legitimate. The court emphasized that the discharge of the guarantor’s liability is contingent upon explicit contractual terms or voluntary actions by the corporate debtor. The ruling affirmed the legality of the 2019 Notification, providing clarity on the liability of personal guarantors under the Insolvency and Bankruptcy Code.
The evolving legal landscape surrounding the liability of personal guarantors underscores the need for clarity and consistency in interpreting contractual obligations and the implications of insolvency proceedings.
CONCLUSION
The advent of the insolvency regime for personal guarantors under the Insolvency and Bankruptcy Code has introduced a new layer of complexity for those considering the role of a guarantor. The ability to initiate parallel proceedings against corporate debtors and their guarantors empowers creditors with a robust mechanism to enforce debt recovery, thereby mitigating the risk of evasion by personal guarantors. However, this process is not without its challenges. The significant authority vested in the resolution professional and the equal treatment of all creditors, regardless of their nature, could potentially lead to an increase in insolvency actions against personal guarantors.
While the regime aims to bolster creditor confidence and security, it also exposes personal guarantors to the harsh realities of insolvency, including the potential loss of personal assets and credit standing. The recent judicial affirmations have further solidified the position of creditors, possibly inciting a more proactive stance in pursuing guarantors. This shift necessitates a heightened level of diligence from individuals providing personal guarantees, as they must now navigate the intricate risks associated with their financial commitments.
The insolvency framework for personal guarantors marks a progressive step towards safeguarding creditor interests, it also calls for a careful balance to protect the rights and interests of guarantors. The current legal landscape underscores the need for ongoing legislative and procedural refinements to ensure an equitable and effective resolution process for all parties involved.
[1] https://www.indiacode.nic.in/bitstream/123456789/19722/1/a1909-03.pdf
[2]https://www.indiacode.nic.in/bitstream/123456789/12905/1/the_provincial_insolvency_act%2C_1920.pdf
[3] https://indiankanoon.org/doc/438563/
[4] https://www.indiacode.nic.in/bitstream/123456789/2154/1/AA31__2016.pdf
[5] SLP(C) No. 016463 / 2021
[6] https://www.mca.gov.in/Ministry/pdf/Notification_18112019.pdf
[7] section-128-of-Indian-contract-act-1872-surety-liability/
[8] 1982 AIR 1497, 1983 SCR (1) 561
[9] AIR 2018 SUPREME COURT 3876, 2018 (6) ABR 42, 2019 (1) ADR 661, (2018) 191 ALLINDCAS 239 (SC), (2018) 191 ALLINDCAS 239, (2018) 2 WLC(SC)CVL 463, (2018) 3 BANKCAS 593, (2018) 4 MPLJ 23, (2018) 4 RECCIVR 110, (2018) 5 ANDHLD 162, (2018) 5 MAH LJ 692, (2018) 6 BOM CR 47, (2018) 9 SCALE 597, 2019 (134) ALR SOC 23 (SC), (2019) 1 CLR 245 (SC), AIR 2018 SC (CIV) 2721, AIRONLINE 2018 SC 113
[10] CIVIL APPEAL NO. 8766-67 OF 2019
[11] 2021 SCC Online SC 396
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